Phase Four Run-Up: When Congress Finally Asked 'How Bad Is This?'
This is post 5 in my series on The Commercial Real Estate Tsunami: A Survival Guide for Lenders, Owners, Buyers, and Brokers by Tony Wood, with a foreword by Matthew Anderson (ISBN: 978-0-470-63637-4, published by John Wiley & Sons, 2010). Chapter 4 covers “Phase Four: The Run-Up” and it’s honestly the most intense chapter so far. This is where the wave makes its final approach and Congress finally starts asking, “Wait, is this a systemic threat?”
Previous post: Phase Three: Drawdown
The Wave Hits Shore
In a real tsunami, the run-up is the last stage. The wave surges forward, flooding deep inland, destroying everything in its path until the momentum finally fades. Wood mapped this to 2010-2013 in the commercial real estate world. And to make his case, he didn’t just rely on his own analysis. He brought in the actual congressional testimony from July 9, 2009.
The hearing was titled “Commercial Real Estate: Do Rising Defaults Pose a Systemic Threat?” And the answer from every single person on the panel was yes.
The Hearing That Should Have Scared Everyone
Wood includes the full testimony from multiple heavy hitters:
- Jeffrey DeBoer, President and CEO of The Real Estate Roundtable
- James Helsel, Partner at RSR Realtors, testifying for the National Association of Realtors
- Jon D. Greenlee, Associate Director at the Federal Reserve
What Wood noticed while watching the hearing was that members of Congress seemed to be just catching up to how bad things were. They were asking basic questions like “Is this truly a systemic problem?” The panel’s unanimous answer: absolutely yes.
Then came the question Wood dreaded: “What if we do nothing?” The answers were not good.
And here’s the number that made everyone in the room sit up straight. When asked what percentage of GDP commercial real estate represents, Jeffrey DeBoer answered: roughly 13 percent. That’s not a small niche market. That’s a massive chunk of the entire economy.
The Numbers Were Brutal
The testimony laid out some genuinely shocking figures:
- Commercial real estate in America was valued at $6.7 trillion, backed by $3.5 trillion in debt
- The sector supported roughly 9 million jobs
- Transaction volume had fallen by nearly 80 percent
- Property values had dropped an estimated 35 percent from peak
- CMBS issuance went from $230 billion in 2007 to $12 billion in 2008 to zero in 2009
- An average of $400 billion in commercial real estate debt was coming due every year for the next decade
- Over 5,300 commercial properties were already in default, foreclosure, or bankruptcy, worth more than $100 billion
The credit system simply did not have the capacity to refinance all this maturing debt. And without refinancing, even properties that were performing just fine would default simply because their loans came due and there was nobody to lend them new money. Wood calls these “maturity defaults,” and they’re particularly frustrating because the property itself might be doing great. The problem is entirely about the lending market.
Real Stories From the Ground
The NAR testimony included stories from actual brokers on the ground, and these really bring the crisis to life.
A Memphis apartment broker described trying to sell one property on five separate contracts. Four out of five fell through because of no financing available. He called it the worst lending market in his 25 years in the business. Lenders were saying no before they even looked at the numbers.
An Atlanta industrial broker had an even wilder story. He found a warehouse selling at 80 percent below replacement cost. Instead of asking for the typical 75 percent loan, he flipped the ratio and came with 75 percent equity, asking the bank for just 25 percent financing. His primary bank still said no. Several other banks said no too. His team had bought or developed nearly a million square feet of industrial real estate. Never missed a payment. Never defaulted. And they still couldn’t get a loan for 25 percent of the purchase price.
That’s not a market correction. That’s a market that stopped functioning.
What the Federal Reserve Said
Jon Greenlee’s testimony from the Fed was equally blunt. Property sales had gone from quarterly volumes of roughly $195 billion at peak to about $20 billion in early 2009. About 7 percent of commercial real estate loans on banks’ books were delinquent, nearly double from a year earlier. And the CMBS market, which used to provide about 30 percent of new lending, was completely dead.
The Fed acknowledged they’d been watching commercial real estate concentrations at banks since the early 2000s. They’d even issued guidance in 2006 warning about the risks. But the damage was already done. Many small and medium-sized banks had commercial real estate exposure equal to several multiples of their capital.
The Fed talked about TALF (Term Asset-Backed Securities Loan Facility), stress tests, and examiner training. But Greenlee was honest about the bottom line: it would take time for the banking industry to work through these challenges. And they needed to be careful not to repeat past mistakes while trying to fix current ones.
The Policy Wish List
The Real Estate Roundtable came with a five-point plan:
- Extend the TALF program beyond its December 2009 deadline through 2010
- Create a federally backed credit facility for new commercial real estate loans
- Reform FIRPTA to encourage foreign investment in U.S. real estate
- Give lenders more flexibility to extend and restructure performing loans
- Don’t raise taxes on real estate investment during a crisis
The FIRPTA argument was interesting. Under existing law, foreign investors selling U.S. real estate got taxed at full U.S. rates, which didn’t apply to most other types of foreign investment. This pushed foreign money to Brazil, China, and India instead of the U.S. market. With an estimated “equity gap” exceeding $1 trillion, attracting foreign capital seemed like an obvious move.
The Ripple Effects Nobody Talks About
What really stuck with me was the breakdown of who gets hurt when commercial real estate collapses:
- Pension funds with roughly $160 billion invested in commercial real estate equity would see smaller returns for retirees
- Construction, hotel, and retail workers would face layoffs and cancelled projects
- State and local governments would lose property tax revenue, recording fees, and transaction taxes
- Communities would see cuts to education, road construction, law enforcement, and emergency services
It’s easy to think of commercial real estate as something that only affects investors and bankers. But when 13 percent of GDP starts breaking down, everyone feels it. Your kid’s school budget. The potholes on your street. The firehouse that can’t replace old equipment. All connected.
My Take
This chapter hit harder than the earlier ones because it moved from data and predictions to real people in real rooms sounding real alarms. Wood was right to include the full congressional testimony instead of just excerpts. Reading the actual words of these industry leaders and regulators, you can feel the urgency.
But what struck me most was Wood’s observation about Congress seeming like they were just catching up to the problem. By the time they were asking “Is this systemic?”, the answer was already obvious to anyone working in commercial real estate. The gap between what industry insiders knew and what policymakers understood is a pattern that keeps repeating in financial crises.
The February 2010 Congressional Oversight Panel report, which Wood flags as essential reading, would later confirm everything this testimony warned about.
Next post: Bailing Out a Sea of Debt
This post is part of a series retelling The Commercial Real Estate Tsunami by Tony Wood (ISBN: 978-0-470-63637-4). Congressional testimony referenced in this chapter was presented before the U.S. Joint Economic Committee on July 9, 2009.